Issue Date: January 28, 2008
Entering The Tiger Cage
"ASIAN TIGERS" is the name economists have used for years to describe fast-growing countries in the Pacific Rim. Today, China and India rank among the world's largest economies and are growing faster than many of the smaller original tigers.
But when the tigers were born a few decades ago, India, for example, was the "tiger in the cage—and the cage was bureaucracy, corruption, and protectionism," says Excelsyn Chief Executive Officer Ian Shott, who has traveled to Asia many times during his career. In the mid-1990s, after India agreed to follow international trade and intellectual property (IP) laws, "the tiger was still in the cage, but the gate was open," he adds.
Shott is amazed by the changes he sees today. "The tiger is out," he remarks. India has advanced far technologically, although it suffers from basic infrastructure problems. China, meanwhile, has rapidly built its infrastructure but has a legacy of environmental, health, and safety problems.
The fine and custom chemicals industry has gradually migrated into the lairs of these economic tigers. In 1999, the top 40, primarily Western, suppliers of life sciences intermediates had a combined market share of about 26%, says industry consultant group Jan Ramakers. By 2006, the share held by the top 40 had dropped to 18%, in part due to emerging Asian producers. Companies in India and China now manufacture a significant portion of the world's active pharmaceutical ingredients (APIs) and intermediates at much lower cost than their Western competitors.
Many Indian companies, already enjoying the advantage of low-cost production economics, globalized their operations overnight by buying Western businesses. Nicholas Piramal India Ltd. (NPIL), Dishman Pharmaceuticals & Chemicals, and Shasun Chemicals & Drugs made big European and North American acquisitions in 2005 and 2006.
This past year, Dishman bought Solvay's fine chemicals and vitamins business in the Netherlands, and Jubilant Organosys purchased Spokane, Wash.-based Hollister-Stiers Laboratories. NPIL and Shasun, as well as Hikal and Arch Pharmalabs, also invested further in building their businesses.
TO COMPETE NOW, U.S. and European custom chemical companies that have long depended on advantages in technology, IP protection, and regulatory compliance are diversifying their operations to leverage lower cost production. Many have been searching for suppliers and partners in Asia. Some have jumped in with both feet, acquiring assets or building plants in China and R&D centers in India.
"It's an ongoing exercise, but the challenge of low-cost economies has to some extent been met by the better Western companies," says David Moody, vice president for commercial operations at Almac Sciences in Northern Ireland. "And it has really helped us to raise our games considerably." Competition has brought "tremendous evolutionary pressures" that necessitate looking closely at one's efficiency and effectiveness in the marketplace, he says.
"We have come to the conclusion that building substantial new manufacturing assets in the West is not the way for us to go, and we question whether it's the way for anyone to go," Moody says. "Our strategy very much has been to build relationships with others that already have relatively low-cost plants, wherever they may be."
The approach provides flexibility and IP protection, Moody says, because Almac manages and underwrites the final products. The company works with a customer to develop a chemical process, which is then transferred into third-party production assets of the customer's choice based on Almac's recommendations.
Rather than simply finding the lowest cost capacity on a one-off basis, Almac tries to build long-term partnerships. In addition to having cost-effective assets with the right capabilities, partners must be committed to protecting IP and addressing environmental, health, and safety (EHS) concerns, Moody adds.
In Asia, Almac looked first to India because of the educational and cultural ties between the U.K. and that country. These connections, Moody says, facilitate the evaluation of an Indian firm's technical competencies and its analytical, quality assurance, and project management capabilities, as well as its EHS practices.
Conducting a thorough audit is "an investment that we and our customers can then benefit from again and again," Moody says. In India, Almac has active projects with Jubilant Organosys. Almac also works with a few Chinese raw material suppliers, and Moody sees these interactions possibly expanding.
SOMEWHAT DIFFERENTLY, Excelsyn inherited a partnership with Shanghai Organic Synthesis Development (OSD) when it acquired Great Lakes Chemical's fine chemicals business in 2004. Under the relationship, which is nearly a decade old, OSD upgrades a key raw material using Excelsyn technology, explains Excelsyn Chief Operating Officer David Rowles. Back in the U.K., Excelsyn conducts analytical testing and then approves for market what OSD made in China.
"We manage the relationship by sending our compliance manager there and by helping OSD with audits from the major pharmaceutical companies," Rowles adds. Shott describes it as a symbiotic association through which Excelsyn offers a project-managed relationship with a trustworthy Chinese company. For its part, OSD can familiarize itself with Western expectations for good manufacturing practices (GMP) and EHS standards.
Excelsyn's China strategy is getting a lot of traction in the marketplace, Rowles claims. "Up until last year, we were doing moderate volumes for eight compounds, but that now has accelerated," he explains. "One particular project with a major pharmaceutical company is now a multi-million-dollar piece of business." Excelsyn and OSD are discussing extending the scope of their mutually exclusive agreement.
Excelsyn may set up an office and quality control labs in China to take further advantage of sourcing opportunities and cost savings. "We also recognize that some of our customers are setting up bases in China, and we want to have a Chinese company so we remain in the loop," Shott says. An agreement between One NorthEast, a U.K. regional development agency, and Shanghai High-Tech Business Incubator Network will allow Excelsyn to set up operations in the Shanghai Research Institute incubator.
Shott has also been looking at projects in India, but with a different mechanism in mind. He believes Indian partners may be best able to help accelerate development of some of Excelsyn's patented technologies.
"When it comes to GMP production and product development, India still has a position over China," he says. "Our plan would be to partner with a company we know in order to set up an Excelsyn technology company, probably in Mumbai." Shott sees potential for new customers because several Indian generic drug producers have started discovery programs with the goal of becoming innovator pharmaceutical companies (see page 41).
Similarly, Evonik Industries' chemical business (formerly Degussa) has made different choices in India and China. The company has a 51% stake in Lynchem in China, a partnership with Hikal in India, and its own R&D center in Mumbai. "China is strong in educating engineers for production, but India is much stronger in generating very good process development people, and that is why we decided to go with a separate R&D center in India rather than China," says Rudolf Hanko of Evonik.
Evonik found Hikal and Lynchem after searching among several hundred firms. It wanted to partner with a recognized player that has top technology, complies with all laws, and shares a business model focused on custom manufacturing, not generic products. This last condition alone eliminated all but about 50 contenders, Hanko says. Looking at competitive technologies shrunk the group to about 20, and the remaining conditions reduced the list to less than 12.
The former exclusive synthesis business had previously decided against building its own operations in China, Hanko says. "Although not legally or technically hard, it's very difficult to build competitively in China if you are on your own." Western companies face higher prices for equipment and construction and thus immediately lose much of the anticipated cost advantages, he adds.
Instead, the business looked for a business combination in which it could be a majority owner. "Especially in China, contracts are of limited value, and what counts is ownership," Hanko says. "Even if a Chinese firm has top standards in environmental protection, in IP protection, and in technology, many customers want to see our name and be assured that we are in control."
The Degussa Lynchem joint venture is part of an Evonik strategy to expand its geographic base beyond Europe, according to Hanko. "Horizontal integration has allowed us to leverage the lower costs of Asia, and this has been very well received by our customers," he says. This has meant new inquiries from customers who, Hanko maintains, see the change as an opportunity for them.
"We can create a win-win situation because we can offer competitive prices and get fair margins for us," Hanko explains. "In the past it was always a headache. Either you offered attractive prices and had to take a serious hit on your margins, or you wanted to get those margins but had difficulties offering competitive prices."
PRICE COMPETITION from low-cost Asian producers of steroids led Pfizer CentreSource (PCS) to rethink its business strategy a few years ago. It now works with two partners, Shanghai Pharmaceutical Group and ScinoPharm in Taiwan, to "marry the best of both worlds," says Jeffery W. Frazier, PCS vice president for fine chemicals.
"We decided to split our steroids supply chain, doing the bioconversion in Kalamazoo, Mich., and then moving intermediates over to partners who complete the chemical processing," he says. With this strategy, PCS can keep its proprietary large-scale bioconversion capability for steroid intermediates in the U.S. and move the labor-intensive chemical steps overseas.
"Our steroid technology is different from the Chinese manufacturers', and we think we can provide the best value and be competitive by manufacturing the intermediates in Kalamazoo," Frazier says. "Asian manufacturers have certain cost advantages in doing the downstream processing." Nevertheless, PCS is asking its partners to duplicate the chemistry used in the U.S. so that the products are still made by the Pfizer process.
"What we are doing is much more complex than just sourcing APIs," Frazier says. "We are transferring not only the chemical technology but also the analytical methods and all of the related information to execute the exact same process."
Pfizer's goal is to make the site of manufacture the only change, allowing the Chinese-produced steroids to be qualified with regulators as equivalent to those it makes in the U.S. As a result, Frazier says, customers should see little regulatory impact. PCS expects to start making material available for customer qualification this year.
The shift will, however, require PCS to conduct quality assurance testing and prove product comparability. These guarantees are important in light of an influx of Chinese manufactured goods of questionable quality. "Our intention isn't to be just a source from China," Frazier says, "but to be a Pfizer source and to continue to provide an assurance of supply, strong GMP compliance, and strong EHS commitment, along with our customer service, regulatory, and technical support."
PCS is transferring one product at a time and has conducted production trials for progesterone. "We want to make sure we get products into the marketplace appropriately before bringing the next one along," Frazier says. It has had to substantially trim its portfolio of about 100 steroid products to a feasible number for transferring. "We have focused more on the core products and not so much on line extensions, such as every ester or salt," he adds.
IN CONTRAST to others following a partnership route, Lonza has decided to go it alone. Although most of the world's pharmaceutical consumers are outside Asia, the Swiss company expects a massive market to develop there. "It's our long-term vision to participate in this growth," says Lukas Utiger, head of Lonza's life science ingredients division. "There are some short-term opportunities on the cost side, but the long-term thinking is to tackle the market."
The company's positive experiences in China since setting up vitamin production there in 1995 have encouraged it to make further staged investments. Today, Lonza is spending $200 million to add API and intermediates facilities in Guangzhou, where it already has two R&D centers. Last September, the company started up a small-scale GMP plant that can produce batches of up to several hundred kilograms. It will be joined this summer by a ton-scale API plant.
Although China is known mainly as a source of non-GMP intermediates, Lonza is going ahead with final-stage API facilities. "When we built the first plant, we saw that you can actually run GMP in China. If you have a lot of local engineering support, you can actually build GMP plants using Chinese equipment," Utiger says.
Strong local government support is a key to success. "It has an unbelievable positive effect, if you manage the relationship properly," Utiger says. "It has nothing to do with bribing; it's more that you really share your concerns and show the government what technology you can bring in and how much you can add to the wealth of the city."
Lonza has invited Chinese officials to see how it operates its non-Asian plants as a demonstration of its environmental performance. The benefits of such goodwill actions can include secure power supply in times of regional blackouts or timely construction permits, Utiger says.
Permitting is one of the challenges of building multipurpose plants in China. "For the Chinese, one plant always produces one product, and the permit is for one product," Utiger explains. "To introduce such new concepts always takes long discussions and a lot of training from our side, and here good relationships help."
Lonza likes to build large, integrated sites, and it has benefited from an established team of local and expatriate engineers that have been operating in China for more than a decade. "The more you do, the more you get accustomed to the Chinese rules and regulations and the more you master the details," Utiger remarks.
He and other executives describe tremendous changes in China during the past 10 years. They say the most evident ones are in air, rail, and road transportation, whereas India continues to be plagued by serious transportation problems and poor utilities, not to mention its sultry climate.
SAFC WEIGHED these and other factors when it needed to add production capacity. As the custom chemicals business of Sigma-Aldrich, SAFC wanted an Asia-Pacific manufacturing hub to accelerate sales in the region. Following its "buy or build" approach, it evaluated many sites.
Although buying a facility might have been quicker, SAFC decided to build instead. "Most of the facilities that were available were 20 to 30 years old and not very flexible, having been constructed with just a few products in mind," SAFC President Frank Wicks says. "The ones in China, and less so in India, were generally in really bad shape and would have cost a lot to repair."
In 2006, SAFC opened a $12 million medicinal chemistry facility in Bangalore, India, for chemical development and small-scale GMP manufacturing of intermediates.
For larger scale production, though, Wicks looked to China. "India has a high-quality workforce and can produce quality products, but China has decided to get the infrastructure right first, and in the long term, I think that is going to play better," he says.
SAFC visited several industrial parks and selected Wuxi New District, located about 75 miles west of Shanghai. The 85-sq-mile high-technology park has more than 1,200 registered companies. Among its features are utilities, wastewater treatment, communications, and customs-clearing services, as well as training and human resources support.
Sigma-Aldrich will initially spend $25 million on a long-term lease for land and to build a large, multipurpose non-GMP plant to support SAFC's Pharma, Hitech electronic materials, and Supply Solutions businesses. Wicks envisions at first taking advantage of lower raw material and production costs and using the plant to make routine high-volume products for local and international markets.
To ease tech transfer, the main plant will duplicate an SAFC facility in Wisconsin, Wicks explains. "Capital costs are about 30% of what they would be in the U.S. for building the facility," he says. And although land in China is more expensive, local incentives allow companies to recoup about 40% of their costs if they fulfill long-term commitments to expand.
"Down the road, maybe within five years, our next areas of investment will be for the Hitech business and possibly a GMP facility," Wicks says. "The thinking would be to get this first facility under our belt and make sure we understand what we accomplished." SAFC anticipates breaking ground on its first plant in March and completion in 12 months.
Wicks and other Western executives emphasize that their companies will operate in Asia by the same EHS and regulatory standards as they do elsewhere in the world. Lonza has done this from the start, and the investment has paid off over the years—for example, in terms of better energy efficiency and quality management, Utiger says.
"On the quality side, we have a limited number of core suppliers that we have been working with for several years," Utiger says. Lonza regularly visits its suppliers and tries to manage quality together with them. "It was difficult at the beginning to agree on how to do quality assurance," he admits. "For these companies, it was a step forward into a different area and it took training from us on why we do things and what we wanted to have as documentation."
Company executives say it's tough to determine which firms will be most dependable partners and suppliers. Because of the risk entailed, some industry participants believe that pharmaceutical companies wanting to lower costs will leave it to the custom chemical industry to work with Asian companies rather than do it directly.
IN THIS SENSE, China's economic and industrial growing pains could have positive ramifications for Western companies operating there. China was frequently in the news in 2007 because of product quality problems, scandals in food and drug regulation, and worsening environmental performance. Enforcement of regulations and laws in the country has been uneven at best.
In response, the Chinese government has launched a new pollution cleanup plan and intends to reform its drug oversight. In July, the government reduced a tax rebate that had helped promote exports and discourage imports. And more recently, Chinese officials have been talking to counterparts from other nations about how to manage economic growth, control currency fluctuations, and curb inflation.
The Chinese government has been pressuring local companies to improve their environmental compliance, which has increased producers' costs and may challenge their competitiveness. But because of the sizeable cost differential between China and Europe or North America, Western companies still can reap savings, even as costs increase in China. Meanwhile, many older, overstaffed state-owned facilities are being shut down.
"This process of consolidation is affecting us very positively because a huge number of competitors are disappearing from the market," Hanko says. Finding the right partner in the first place is critical to avoid problems and ensure longevity in the relationship. "It's very positive for our business that Degussa Lynchem is recognized as a top player in China with regard to IP protection and to environmental and safety standards," he adds.
Increased enforcement of wastewater treatment has impacted the steroids market, PCS's Frazier says. In China, diosgenin, a steroid precursor, is typically extracted from yellow ginger in a process that can be environmentally unfriendly. As a result, many diosgenin producers have been forced out of the market, raising raw material prices for Chinese steroid producers. PCS doesn't face this problem because its process uses soybean-derived sterols to make intermediates.
Not all the changes have been positive. PCS and other companies operating in China also face the decreased tax rebate. China has a 17% value-added tax on products, and the government used to give producers a 13% rebate on exports. In July, the rebate was dropped to just 5%, imposing an effective 8% price increase. Costs for non-GMP intermediates and some raw materials have been rising rapidly.
"The lower rebate really cuts into margins," Hanko says. "We have been quite successful in striking good deals with our customers where both sides take part of the burden. I know of other cases where people have not been able to off-load at least part of that increase, which can get fairly critical."
EVENTUALLY, the cost advantages of working in China will diminish, as has already started happening in India, but it's uncertain how quickly the gap will shrink. The Chinese government's desire to fix environmental problems has slowed the permit process and the allocation of land for plants, some industry participants say. Inflation, meanwhile, is contributing to higher costs for goods, raw materials, construction, and labor, others note.
Costs do vary by region, being higher in developed, westernized cities like Shanghai and lower in outlying districts or other cities. Even so, Rowles says costs in Shanghai are still significantly lower than in the U.K. And although salaries are increasing by double-digit percentages, "a staff or shift worker in a GMP plant in Northern China earns 150 to 300 euros per month, so you can afford a number of years with high salary increases," Hanko points out.
Just comparing salaries between Asia and Europe doesn't give the full picture, Lonza's Utiger cautions. "There are short-term cost benefits, but you shouldn't forget that there are high demands in communications and the management time you have to spend to really get the right results."
Costs aren't the only issue. "The most important issue is, 'Will there be access to enough chemists and engineers in the future?' That's something we see as a big challenge five or 10 years forward," Utiger says. China and India, most executives say, are good sources for engineers and chemists. Individuals with industry experience, especially at Western companies, are very valuable.
Worker availability varies by region. "In Dalian, we have good sources and get very good people, but there are definitely regions in China where you find very competitive labor markets and where it's fairly difficult to attract the right people," Hanko says.
At present, there are more Ph.D.s and more individuals with industry experience in India than in China, where many workers come from state-owned companies. Nevertheless, China has a strong educational system that will produce the next generation of chemists and engineers, Excelsyn's Shott points out. He serves as a technical vice president in the Institution of Chemical Engineers, an international group that is looking to accredit university engineering programs in China.
LANGUAGE, cultural, and business differences can make it challenging for Western managers to run a new facility, particularly a GMP one where it helps to have English-speaking employees who can communicate with regulators. One way to avoid some of these West-meets-East management problems is to partner with an established Asian company or to employ local people.
Wicks says SAFC will first send a plant manager from Wisconsin to oversee the project in Wuxi but eventually hopes to hire a China national with industry experience. "One of the most difficult parts of being successful is actually finding the right talent," he says. Good people can be found at the right price, but keeping trained employees can be a challenge and is one reason wages continue to rise, he adds.
Turnover can occur when competitors hire people away or when entrepreneurial employees decide to strike out on their own. But Chinese workers are developing a sense of company loyalty, Utiger says. "If you manage to grab the good people, and you generate good feelings by providing, for example, medical and housing benefits, they are very loyal," he explains. "But you must give them development opportunities and they have to see that they are part of a team that really moves forward."
Although worker loyalty may be on the rise, executives acknowledge that some workers still walk out the door with know-how or even patented processes. In Asia, some companies have addressed IP concerns by sending over older processes. Others have transferred up-to-date processes but kept critical aspects, such as proprietary catalysts, under tight control. Others yet carefully manage data handling or limit access to company information.
DESPITE THE CHALLENGES, Western companies keep moving east. In 2007, Albany Molecular Research Inc. spent $11 million to acquire two pharmaceutical chemical plants in India, as well as land for expansion. During the next three years, AMRI says, it will invest about $15 million to increase capacity and bring the sites into GMP compliance. The company also opened an Indian research facility. And drug development services firm Aptuit has created a joint venture with Laurus Labs in India. Aptuit plans to put $100 million over four years into Aptuit Laurus.
Just recently, DSM's anti-infectives business entered a manufacturing agreement for generic APIs with Mumbai-based Arch Pharmalabs. DSM says it will contribute technologies and market access, and Arch will apply its Indian asset base and chemical conversion expertise. Separately, DSM is building corporate R&D labs in the Zhangjiang Hi-Tech Park in Shanghai.
The pros and cons of setting up operations or partnerships in India and China are wide-ranging. India has been in the pharmaceutical fine chemicals game longer, and it has highly trained scientists, a better regulatory track record, and an improving legal picture. China is cheaper and offers a better infrastructure, but the production assets there vary widely in quality and often lack quality assurance safeguards. Although there are many opportunities in Asia, there are also many uncertainties related to inflation, employment, and governmental actions.
These are considerations that companies shouldn't take lightly when thinking about working in Asia, Almac's Moody cautions. "It's a very specialized activity in its own right," he says. "We've tried to become good at it and will become better as we do more of it."
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